Pub. 10 2020-2021 Issue 1

O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S — H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S July • August 2020 15 V olat i lit y in oi l commodit y markets has been unprecedented in recent weeks, and challenges may lie ahead for many banks who lend to borrowers in the oil and gas industry. On April 20, 2020, oil futures contracts went negative for the first time in history, as the combined effects of drastically decreased demand due to the coronavirus and the oil price war between Saudi Arabia and Russia left the market hopelessly oversupplied. The O&G industry receives funding fromnumerous sources. “A traditional role of bank credit in the O&G industry has been to finance E&P Capex. The repayment of E&P loans depends primarily on revenues and cash flows generated by the successful acquisition, development, completion, and production of O&G reserves, and secondarily on the liquidation of O&G reserves securing the debt.” 1 The loan structure of choice for E&P financing is a reserve- based loan or RBL. O&G RBLs often have three- to seven-year terms with a maximum credit line pegged to the value of a borrowing base consisting of oil and gas collateral. The O&G E&P industry is unique because it is dependent on the reserves extracted from wells with finite capacity. As borrowers sell oil and gas, reserves deplete. This stands in marked contrast to many other industries, where assets increase over time. As a result, and also because of the significant price volatility, the value of the borrowing base is periodically re-evaluated, and the maximum loan amount adjusted accordingly. As borrowing bases tighten this year, some oil and gas companies will find themselves in difficult positions. Against this backdrop, Colorado lenders should take swift action to analyze loans and loan portfolios and take steps to dot “I’s,” cross “T’s,” and stake out the best position to weather the storm. Among other things, banks would be well advised to consider all of the following: • Makeongoingmonitoringapriority.“Ongoingmonitoring is critical to prudent E&P lending. Ongoing monitoring entails not only remaining well-informed of the borrower’s operations but also independently keeping up with market events that may affect the borrower. Banks should update their price decks at least semiannually. The updated lender analysis should be documented and should consider whether the borrower’s ability to repay committed debt remains within the bank’s underwriting standards.” 2 • Review documentation against perfection rules under UCC Article 9 and other federal and state statutes. Lien priorities are the name of the game if bankruptcy comes into play. Frequently, lenders don’t pay enough attention to Article 9 fundamentals and how the UCC interacts with other federal and state statutes until it may be too late to fix problems. As a general rule, rights in mineral leases, improvements, “as-extracted collateral,” and fixtures are subject to local filing in the county where the collateral is located. (UCC 9-502 sets forth a series of requirements that must be followed if a real property mortgage is to double as a financing statement for fixtures or as-extracted collateral.) • Beware of ever-changing collateral and the need to update perfection documentation. Since E&P companies are constantly depleting fields and acquiring new leases, care must be taken to ensure that the lender obtains and perfects security interests in the ever-changing collateral. • Refresh understanding of OCC examination procedures. Bankswith significant oil and gas loanportfolioswouldbe well advised to review the OCC’s examination procedures applicable to the E&P lending examination to prepare for the difficult months to come. 3 • Beware of a spillover effect. Even banks with limited direct exposure to the oil and gas industry, but with significant loan portfolios in areas with high concentrations of oil and gas operations, should consider whether turmoil in the O&G sector will spill over into surrounding businesses. • Declaring default and exercising enforcement powers is tricky. Article 9 enforcement powers generally can’t be used unless the debtor is in default on the secured obligation. Premature enforcement is asking for a lender liability lawsuit. Since Article 9 contains no definition of “default,” the secured lender needs to define the “events of default” carefully in the security agreement. UCC 9-601. Issues with documentation, including the definition of “default,” sometimes can be cleaned up as part of a forbearance agreement. Getting legal counsel involved early with these tricky issues is a good idea. n 1 Office of the Comptroller of the Currency, Oil & Gas Exploration & Production Lending: Comptroller’s Handbook 10 Ver. 2.2 (Oct. 15, 2018), (O&G Booklet). 2 O&G Booklet, 28. 3 O&G Booklet, 41–65. This story was written by Matthew Clark, a commercial litigator with Faegre Drinker Biddle & Reath LLP and co-author of Clarks’ Oil and Gas Financing Under the UCC. This story is reprinted fromClarks’ Secured Transactions Monthly with permission. Copyright 2020 Matthew Bender & Company, Inc., a LexisNexis company. All rights reserved. The information presented in this story does not constitute legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed herein. Oil and Gas Loans: Some Best Practices for Troubled Times